Trading uncovered: What is CFD trading?

CFDs or contracts for difference are a trading instrument. By trading CFDs you can make profits from rises and falls in the stock market.

So what are CFDs? And how does CFD trading work? Let’s take a closer look…

What is a CFD?

A CFD is an over the counter (OTC) derivative product. A derivative describes a financial product which derives its value from another financial instrument.

For example, a Sasol CFD derives its value from the price of a Sasol share.

One CFD equals one underlying share. This is different from other derivative products like single stock futures, where one contract is equal to 100 underlying shares.

The definition of a CFD

The formal definition of a CFD is:

A CFD trade is an arrangement between two parties to exchange the difference between the closing price and the opening price of the contract. This agreement is between you and the market maker.

To allow CFD trading to take place, there are market makers. These market makers provide a market for the trading of CFDs to take place. They include banks and spread trading companies.

You can trade CFDs on equities and indexes, the team of experts at FSP Invest in The Ultimate Contracts for Difference Guide explain. So if you want to trade indexes for example, CFDs are the perfect tool for that.

The pros and cons of trading CFDs

Trading CFDs comes with its risks. It’s a geared product. This gearing multiplies your gains, but it also multiplies your losses. This is because you trade on margin.

So trading CFDs isn’t for the risk adverse.

One of the main reasons why traders use CFDs is to take advantage of rising and falling shares.

For example, if you thought the price of Sasol shares were going to fall, you could short Sasol CFDs. If the price did fall, you’d profit from this,

So there you have it, what CFD trading is.

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